Man Getting Punched in the Jaw

With data showing European wages rose their fastest ever late last year, the Organization for Economic Cooperation and Development (OECD) called on central banks to keep raising rates to battle inflation that has proved unexpectedly stubborn.

Wages on the continent grew by 5.1 percent, year on year, in last year’s fourth quarter, compared to 3 percent in the third, adding upward pressure on prices.

The U.S. Federal Reserve’s key rate should be between 5.25 and 5.5 percent, the OECD urged, compared to 4.5 and 4.75 percent now. 

The Fed meets today and tomorrow and will weigh persistent inflation against turmoil in the banking industry in deciding whether to change its rate.

The OECD cautioned the Fed against pausing its campaign of rate increases, which some economists have urged it to do in light of the banking sector’s uncertainty; they worry that higher rates at a time of instability might sink the global financial system.

However, “we still think that, knowing what we know today, the priority has to be fighting inflation,” OECD chief economist Alvaro Pereira said in comments quoted by The Wall Street Journal.

“This isn’t 2008,” he added. “We don’t see a systemic risk at this stage.”

“Services price growth has remained high, pushing up core inflation, which is why we believe central banks must remain vigilant,” he noted.

The European Central Bank (ECB) raised its deposit rate by a half point last week to 3 percent. However, the OECD said the bank needs to add another three-quarters of a point to that to have a meaningful impact on rising prices.

The Bank of England (BoE) also added a half point to its base rate in its February meeting. The bank should do the same once more and bring the rate to 4.5 percent, according to the OECD.

BoE officials have not committed to future rate increases, pointing to data showing that inflation already is falling in the U.K. faster than expected, due in large part to falling prices for natural gas.

The bank expects Britain’s economy to grow by 1.9 percent this year; the OECD foresees 0.9 percent, less than half the bank’s projection.

Despite some positive signs that food and fuel prices are softening, “global growth is projected to remain at below-trend rates in 2023 and 2024, at 2.6 and 2.9 percent, respectively, with policy tightening continuing to take effect,” the OECD report said.

TRENDPOST: As we have noted most recently in “Raise Interest Rate Higher, OECD Tells Europe’s Central Bank” (29 Nov 2022), central banks in Europe and the U.S. waited far too long to raise interest rates to curb inflation.

ECB president Christine Lagarde was particularly insistent that inflation was temporary.

In November 2021, while we had long forecast surging inflation, Lagarde said she didn’t see it coming and it would be “wrong” to raise interest rates at that point because inflation will begin to cool by the time the new rates would have a chance to impact the economy.

On 3 December 2021, she told the Financial Times that inflation was peaking and that the inflation profile looked “like a hump…and a hump eventually declines.” She said at the time that the ECB is “very unlikely” to alter its interest rate—which has remained negative for seven years—in 2022.

Europe’s economy is still recovering from the COVID War and the current banking crisis is likely to stagger it to some degree.

Therefore, it is unlikely that the ECB will jack its rate soon to meet the OECD’s instructions. Instead, it is more likely to nudge up its interest rate incrementally while waiting for consumers to slow their spending and factories to cut output.

A combination of those factors will bring inflation down, but at a much slower rate than if central banks had acted as inflation first began to take hold.

Skip to content